Buried in the recently enacted Highway Bill, officially the Fixing America’s Surface Transportation Act or FAST Act, is a new exemption for the resale of securities. The new resale exemption appears in the form of a new Section 4(a)(7) of the Securities Act of 1933 and essentially codifies the so-called 4(a)(1-1/2) exemption. New Section 4(a)(7) will provide securityholders seeking to resell their securities without registration greater certainty and another viable alternative exit pathway, particularly from privately held companies. Inasmuch as no Securities and Exchange Commission rulemaking is required, the new exemption is effective right now.
The requirement that each sale of securities be either registered with the Securities and Exchange Commission or satisfy an exemption from registration applies as well to any resale of securities by security holders. Rule 144 is a common exemption for the resale of restricted securities (and of any securities by holders who are affiliates of the issuer, i.e., control securities). Another exemption used by reselling shareholders is the so-called 4(a)(1-1/2) exemption, an unofficial, unwritten exemption conceived by securities lawyers which over time has become accepted practice. It’s called the 4(a)(1-1/2) exemption because it contains elements of both Section 4(a)(1) of the Securities Act, which exempts from registration transactions by any person other than an issuer, underwriter or dealer, and Section 4(a)(2) of the Securities Act, which exempts transactions by an issuer not involving any public offering.
The New Section 4(a)(7) Resale Exemption
New Section 4(a)(7) essentially codifies “Section 4(a)(1-1/2)” by exempting from the registration requirements of Section 5 of the Securities Act resales of restricted securities that satisfy the following requirements:
- securities sold only to accredited investors
- no general solicitation
- if the issuer is not a reporting company, the seller and prospective buyer are able to obtain from the issuer certain reasonably current information about the issuer, including the number of shares outstanding, information about the officers and directors, any persons registered as a broker, dealer or agent that will receive any commission for the transaction; recent balance sheet and profit and loss statements; and if the seller is a control person of the issuer, a statement regarding the nature of the affiliation and a certification by the seller that it has no reasonable grounds to believe that the issuer is in violation of the securities laws
- seller is not a direct or indirect subsidiary of the issuer
- neither the seller nor any person being paid in connection with the sale is a bad actor, as described in Regulation D
- the issuer is not a blank check, blind pool or shell company; and
- the class of securities has been outstanding for at least 90 days prior to the transaction.
New Section 4(a)(7) will provide greater legal certainty to shareholders seeking to resell shares than currently provided in the so-called Section 4(a)(1-1/2) exemption, which was never formally legislated or codified through SEC rulemaking.
New Section 4(a)(7) will also present a viable alternative to Rule 144, the traditional safe harbor for the resale of restricted and control securities, in relation to which Section 4(a)(7) has both advantages and disadvantages.
As to the advantages, sellers under Section 4(a)(7) may sell an unlimited number of shares, unlike affiliates in Rule 144 transactions who are capped in any rolling three month period to the greater of one percent of the outstanding shares or the average weekly trading volume over the preceding four week period. Section 4(a)(7) sellers need not satisfy any holding period, unlike Rule 144 sellers who must hold the shares for either six months in the case of reporting issuers or one year in the case of non-reporting issuers. A Section 4(a)(7) exemption need not be reported in an SEC filing, unlike Rule 144 sales by affiliates. Finally, the FAST Act made explicitly clear that shares sold in a Section 4(a)(7) transaction are deemed “covered securities” for purposes of the National Securities Markets Improvement Act of 1996, meaning that state regulation is preempted and these transactions are not subject to state review.
On the other hand, there are certain disadvantages relative to Rule 144. Shares sold in a Section 4(a)(7) transaction are deemed to be restricted securities in the hands of the purchaser, who would then need to find his own exemption on a subsequent resale, as opposed to shares sold under Rule 144 which become unrestricted. Furthermore, Section 4(a)(7) shares may only be sold to accredited investors, whereas shares sold under Rule 144 may be sold to anyone.
Finally, it will be interesting to see what practices emerge with respect to the information that must be obtained from a non-reporting issuer, including whether issuers will insist on signed confidentiality agreements as a condition to disclosing the required information.